The Mark Carney bubble

It takes guts to stand up in a room full of distinguished men and women and tell them their opinions are ridiculous. This is not a problem for Bank of Canada governor Mark Carney.

In late September, he stood in just such a room at Washington’s Institute of International Finance and publicly criticized the organization’s own report contending that reforms to the financial system were hampering economic growth. Carney offered a sarcastic, “Really?” then pointed out that new regulations won’t take effect for another two years. “If some institutions feel pressure today,” he said, “it is because they have done too little for too long, rather than because they are being asked to do too much, too soon.”

The speech makes obvious Carney’s appeal. He’s intelligent, never lapses into econo-babble, and is a vocal advocate for regulation to lessen the chances and damage of another financial crisis. But while plenty of officials and politicians fit that description, Carney has developed an unusually high profile. In 2009, the Financial Times named him one of 50 who will “frame a way forward.”

Last year, Time called him one of the world’s 25 most influential leaders. (He’s also “smart and sexy,” according to the magazine, a descriptor surely never before applied to a Canadian central banker.) And in May, Reader’s Digest declared him the most trusted Canadian. Beyond the media infatuation, Carney has earned his share of professional accolades, too. Most recently, his name has been floated as the next head of the Financial Stability Board, an international body of regulators and central bankers crafting financial market reforms.

So what is it about Mark Carney? At 46 years old, he is accomplished, to be sure. His resumé—boasting a PhD in economics from Oxford and 13 years at Goldman Sachs—puts most of ours to shame. But Carney has also benefited from circumstance. The Canadian financial system and economy fared better than most during the recession, and he wasn’t forced to respond as dramatically as were other central bankers. Compared to the problems faced by Ben Bernanke at the U.S. Federal Reserve and outgoing European Central Bank president Jean-Claude Trichet, Carney’s tenure has been a cakewalk. “Any governor of the Bank of Canada during this confluence of circumstances would have looked good, simply because the Canadian economy and banks looked good,” says Rotman School of Management professor Laurence Booth.

In a way, Carney has become the living embodiment of decades of Canadian financial prudence—partly through his own actions, and partly for reasons he had nothing to do with. But as his influence grows, so too do the challenges that will ultimately determine his reputation.

When Carney succeeded David Dodge in February 2008, he was relatively young and inexperienced for a central bank governor. He had left Goldman to become a deputy governor at the central bank in 2003, and moved to the Department of Finance a year later. He grasped politics better than some of his colleagues, and understood how the public would react to policy. “He had a well-informed view that wasn’t simply the product of advanced courses in econometrics,” says Karl Littler, who served as an adviser to former prime minister Paul Martin.

His appointment to head the Bank of Canada, however, was something of a surprise since Paul Jenkins, Dodge’s senior deputy governor since 2003, was a strong contender. Carney had also become known for being blunt and impatient with those who couldn’t immediately understand concepts. “A few people there had found him somewhat difficult to work with,” says Rotman professor Paul Masson, who served as a special adviser to the central bank between 2007 and 2008. But while an e-mail sent by the U.S. Embassy in Ottawa to the Federal Reserve at the time of his appointment (unearthed by WikiLeaks) noted Carney had been described as “arrogant” in the press, it countered, “we have found Carney to be not only approachable, but also extremely competent and effective at public outreach.”

He’s put to rest concerns about his youth and demeanour. When the financial crisis hit in 2008, he provided unprecedented liquidity to the banks and cut interest rates to the lowest levels in Canadian history. “His actions contributed materially to helping the financial system through its difficult time,” says Craig Alexander, chief economist at TD Bank Financial Group.

When it comes to forecasting, the central bank’s record under Carney hasn’t been any better or worse than the private sector. Carney’s growth projections in early 2009 were more optimistic than most, which raised questions during a meeting of the House of Commons standing committee on finance. Carney retorted, “We don’t do optimism. We don’t do pessimism. We do realism at the Bank of Canada.” The projections proved too bullish, however, and the central bank revised its estimates downward. It has also pushed back its timeline for raising rates. Still, the past few years have been difficult for forecasters, and markets look to the Bank of Canada for an indication of where interest rates are headed, not specific GDP growth estimates. On that front, Carney has delivered.

Looking back at his performance, though, it’s hard not to wonder if any central bank governor would have acted differently. It’s impossible to say definitively, of course. Glen Hodgson, chief economist at the Conference Board of Canada, points out there is no comparison to what’s happened recently. “What you saw was a collective response of the senior management team at the bank to really exceptional circumstances,” he says, adding that Carney’s private-sector experience and knowledge of financial markets did give him an edge past governors wouldn’t have had. But in talking to economists about Carney, the phrase that often comes up is that “he did everything he was supposed to do.” His actions are simply what we expect from central bankers, partly because he’s the latest in a competent line.

The Bank of Canada underwent a significant change in 1991 when it implemented inflation-targeting to combat the double-digit interest rates that plagued the country during the 1980s. Since then, it has maintained the rate of inflation between 1% and 3%. “Much of the heavy lifting in gaining credibility was done in the 1990s, when the bank didn’t have that much,” says Rotman’s Booth.

The federal government brought down its deficit over roughly the same time period, putting Canada on solid fiscal ground. The banking sector, meanwhile, was tightly regulated by the Office of the Superintendent of Financial Institutions, ensuring our banks didn’t take the risks that American and European institutions did. For all of these reasons, the Canadian financial system and the economy prevailed during the recession. While the crisis was still a trial by fire that Carney handled deftly, Booth likens it to a “little minor campfire…it just hasn’t been as bad a situation as it has elsewhere.”

Nonetheless, other countries took note of Canada’s relative strength, translating into a bigger role for the country internationally, whether at G20 meetings or when Prime Minister Stephen Harper goes on a foreign media blitz to champion Canada.

That golden image has rubbed off on Carney, too—and he wears it well. Paul Martin, now an adviser to the International Monetary Fund, says it’s nearly impossible to do such work and not have Carney’s name come up. Both Trichet and his successor at the ECB, Mario Draghi, have spoken highly of him in private conversations without any prompting from Martin. Unlike finance ministers who come and go based on the whims of the electorate, central bankers are in place for a long time and tend to form an exclusive club on the international scene. “To break into that closed circle as quickly as he has done is a real indication of the high regard in which he is held,” Martin says.

His knowledge and experience with financial markets—which many central bankers lack—and his ability to talk about complex issues in a way people understand help explain why Finance Minister Jim Flaherty stated publicly his desire to see Carney take over the FSB in November when current chair Draghi leaves. Should he take the post, Carney faces a number of challenges. Some are calling for the organization to be given more teeth. Guidelines for issues such as bank stress tests have to be developed and enforced, a complicated process when dealing with more than 20 countries. And there is opposition to reform from the banks. Carney got a taste of it when JPMorgan Chase CEO Jamie Dimon lashed out at him over regulations during a September meeting, allegedly prompting Carney to storm out.

“There is a list of issues as long as your arm the new head is going to have to deal with,” Martin says, adding that strengthening the FSB is “one of the most important things we can do to prevent these kinds of crises.” But it’s questionable whether Carney could complete the work on a part-time basis, as Flaherty suggested would be the case, and still serve his term as governor.

There are challenges at home, too, principally household debt. Low interest rates are encouraging Canadians to borrow at worrying levels, and contributing to a hot housing market. The longer rates stay low, the more debt Canadians pile on, and the bigger the eventual shock when rates rise. Should there be a real estate correction or another obstacle to households paying down debt in the coming years, it will be easy to ask with the benefit of hindsight why rates were kept so low for so long. (Alan Greenspan, the now-reviled former head of the Federal Reserve, found himself in that situation.)

Unlike Greenspan, Carney is clearly concerned and has repeatedly warned Canadians not to borrow more than they can afford. However, “It seemed a little unusual to be keeping interest rates at extraordinarily low levels, and then chastising Canadians for turning around and accepting those very low interest rates,” says Doug Porter, deputy chief economist at BMO Capital Markets. Alexander at TD likens it to providing an open bar at a wedding and warning guests not to overindulge.

But as both acknowledge, Carney’s hands are tied. Interest rates need to be kept low to encourage business lending and bolster the economy in general. Turning off the credit spigot too early could have severe consequences. Few, if any, Canadian economists are advocating for an immediate rate hike. Even the C.D. Howe Institute, which had been calling for an increase as recently as July, reversed course.

The irony is that Carney has built his sterling reputation in part by doing exactly what circumstances required of him—the same approach that may eventually see his reputation suffer a correction, if low interest rates ultimately cause problems. The effects of those low rates won’t fully be felt for some time, however, and for now, Carney’s star remains on the rise. Says Booth, “He’s the right person in the right job at the right point in time.”

This article was originally published in Canadian Business.

Joe Castaldo, Canadian Business